The feud between Meta and Apple has been going on for several years. One of the main reasons behind this is that Apple is unable to obtain a lucrative licensing agreement from Meta similar to the one it has with Alphabet (GOOG, GOOGL) (“Google”). Licensing revenue is probably 100% profit, and recent estimates suggest that the agreement with Google generates revenues of more than 10 billion dollars.
Meta’s performance is likely to be near bottom and we may see better numbers in the near term due to higher monetization from new initiatives and cost cutting across the business.
Overrated headwinds for Meta
After the previous earnings call, Meta experienced one of the biggest corrections in its stock. Much of this correction was due to management concern over Apple’s new privacy policies. Meta mentioned that it could see $10 billion in revenue due to these privacy policies. However, it is likely that Wall Street has overestimated the negative impact of Apple’s privacy rules on Meta. A recent information report mentioned that advertisers are already seeing a recovery in their ad conversion rates on Meta after the initial drop due to Apple’s new privacy policies.
Meta has a number of tools and workarounds to deliver targeted ads despite Apple’s new privacy restrictions. On the other hand, these privacy rules could hurt small app developers who rely on advertising. Small app developers lack the scale and technical depth of Meta. Apple already faces regulatory headwinds in a number of regions, and it wouldn’t want to hurt smaller app developers, as it will be viewed negatively by regulators who want to promote their own digital ecosystem.
The privacy rules will also hurt Google, which has a multibillion-dollar licensing deal with Apple. Current estimates show that the negative impact on Google will be less than that on Meta. However, in the long term, this will be an additional reason for lawmakers to examine the anti-competitive nature of the licensing agreement between Apple and Google.
The jury is still out on what future steps Apple will take on the privacy front. However, Meta has a number of options it can use to reduce the negative impact of these policies.
The Meta monetization campaign
Meta has already taken a number of steps that will allow the company to build a better moat around its advertising business. The company is stepping up its own hardware segment, which will give him more control over the services he provides to customers. The CEO of Qualcomm had recently mentioned that Meta’s Oculus Quest 2 VR set had sold over 10 million units in one year. Meta is also launching new versions of smart speakers, smart glasses and smart watches. Meta has the resources to build a very strong hardware business. Even if these products are sold with very thin margins, the long-term benefits for the entire ecosystem will be significant.
Meta could sell over 100 million units within its hardware business by 2025. This will certainly reduce its dependence on Apple products and its walled garden. Amazon (AMZN) and Google have already cornered a large portion of the smart home device market, and Apple has been unable to significantly reduce their market share. Success in the hardware business should help Meta build better tools for how it uses customer data.
Meta’s massive investment in the metaverse should also help the company build its own walled garden. The company is reporting losses in this business, but in the long run, it will help improve Meta’s ecosystem and strengthen the moat.
Meta mentioned that its Reality Labs division had sales of $452 million while the overall loss was $2.8 billion. Starting August 1, Meta will be increase the cost $100 Quest 2 VR devices. This shows management’s confidence in retaining customers at a higher device price and will also improve this division’s revenue. Management also mentioned that it had reached an annualized revenue rate of $1 billion in Reels.
Lower the costs
Meta’s ability to quickly cut costs is not valued by Wall Street. The company has already reduced its hiring plans, which should help reduce expenses. Meta headcount grew 32% YoY, leading to 22% increase in expenses compared to the quarter of the previous year. On the other hand, turnover fell by 1%. This shows that there have been excess hirings during the pandemic that could be reduced quickly.
Figure 1: Spending growth has not matched revenue headwinds.
Meta has been quite adept at expense management over the past few years. The growth trajectory of income and expenditure has had a strong correlation in the past.
Figure 2: Trajectory of revenues, expenses and number of employees over the past few years.
We can see from the image above that total spending and headcount growth have been similar over the past decade. Meta management can undertake significant tightening to rein in spending and bring it in line with the revenue growth trajectory. It could take another two quarters, but we should see a nice jump in margins from this effort.
Impact on Stock Meta
Meta’s stock has already experienced a correction of more than 50% since the start of the year and it is trading at a P/E multiple of less than 13. This shows that most of the negative impact on Meta is already integrated. The headwind from Apple’s privacy rules will be minor as it causes a lot of collateral damage to other players in the digital ecosystem. Apple wouldn’t want to hurt Google or other smaller app developers who depend on ads.
Figure 3: Meta has significant cash reserves to pursue redemptions.
Meta undertook an additional $5 billion in buybacks, which removed more than 1% of its outstanding shares this quarter. Over the past twelve months, buybacks have totaled more than $50 billion. The company has sufficient reserves and free cash flow to continue redemptions. The modest PE multiple should allow the company to remove a higher percentage of stocks and have a greater impact on EPS.
The recent quarterly report shows that the challenges due to Apple’s privacy policies for Meta are overstated. Meta has launched a number of initiatives and has the resources to meet the short term challenges. Meta stock remains a very good long-term bet due to the company’s strong fundamentals and new segments that can improve the company’s growth track.
Key takeaway for investors
The challenges Meta faces due to Apple’s privacy policies are overblown. It is likely that Meta will build new tools and workarounds to reduce the negative impact of these privacy rules. At the same time, Apple wouldn’t want to harm Google or other smaller app developers that rely on advertising. Apple is already facing challenges in its App Store due to the monopoly payment option. Apple’s new rules that hurt ad-dependent apps could be viewed negatively by regulators in many regions.
Meta is launching new initiatives such as increasing hardware sales, increasing investment in the metaverse, monetizing reels, and diversifying revenue streams. Meta’s stock valuation does not reflect the strength of its platforms and long-term growth options. The cheap valuation of this stock makes it a good bet for long-term returns.